Dark Pool for Dealers Addresses Shortfall in Corporate Bond Liquidity

TMC Bonds and Codestreet have launched the first dealer-only dark pool for US corporate bonds to mine data across a virtual balance sheet.

A new dark pool for trading U.S. corporate bonds has emerged to help dealers identify trading opportunities across their positions and orders as a way to solve the problem of constrained balance sheets.

TMC Bonds, a New York City, owned by a consortium whose backers include Bank of America Merrill Lynch, Citi Global Markets, Morgan Stanley and Assured Guaranty, announced the first dealer -only dark pool on Tuesday together with CodeStreet, a provider of fixed-income sale and trade matching software to sell-side firms.

Codestreet Dealer Pool will enable sell-side firms to anonymously match positions and indications-of -interest across a complete spectrum of high grade, high-yield and distressed debt. The execution platform is for negotiating round lot orders of $1 million or higher in the credit market.

“It’s about using their data to expose previously overlooked trading opportunities so they don’t’ need to use their balance sheets and can do more riskless or risk reducing business,” said Howard Pein, chief executive of Codestreet in an interview. Codestreet’s software is widely used by bond dealers to manage their inventories internally across desks.
Codestreet Dealer Pool is now live and more than 15 dealers are going to be on the platform in the next few weeks, with more than half of them already activated.

The move comes as dealers have been under pressure to do more risk reducing business in response to higher capital charges. Dealer inventories of corporate bonds have shrunk over the past five years, to a fraction of their size, which has led to a liquidity shortfall in the secondary market for institutional trades.

The dark pool will allow the sell side to turnover their balance sheets with increased velocity, and ultimately enable them to serve the needs of institutional clients, said Pein.

“What you have is a virtual balance sheet for the dealers. Now they can essentially leverage the liquidity from all the other dealers on the street,” said Pein.

While some dealer-to-customer platforms are experimenting with developing “all-to-all models”, which could allow buy side firms to bypass dealers and trade with anybody on the platform, CodeStreet’s mission is the antithesis of that, said Pein.
“This is to strengthen the dealer’s traditional role in being liquidity providers,” he said. In fact, Codestreet’s web site says that “all to all is nonsense.”

Currently, dealers trade with one other through voice brokers in the inter-dealer market to match their buy and sell orders, but dealers can be reluctant to share information on anything other than the most liquid bonds.

“The launch of a new dark pool for corporate bonds should certainly help increase liquidity and trading opportunities for dealers of less liquid bonds,” commented Michael Chuang, CEO and founder of iTB Holdings, an aggregator of fixed income platforms, in a statement. “The marketplace is still used to the traditional phone call interaction between counterparties, but a dark pool will increase the momentum of the ongoing automation of trading and liquidity sourcing,” wrote Chuang.

To avoid information leakage, Pein said the ATS is completely dark for matching between dealers and only when “true” counterparties are identified does it reveal a negotiation. Dealers are not notified until a match with a high likely counterparty is found.

Codestreet Dealer Pool uses a dark matching protocol where all the information that particular dealer has and the traders that want to buy or sell, is crossed anonymously, avoiding information leakage, explained Pein.

Codestreet Dealer Pool will utilize algorithms to seek out trade matches amongst the dealers who participate by mining the vast database of existing bonds held by dealers as well as by clients past interest, according to the release.

Many of the sell side firms on the network are already using Codestreet’s fixed income software in their own firms to match orders across their own desks. Codestreet’s client base includes 11 of the top 20 banks, but banks that are not clients can also use the dark pool, Pein said. “The firms are capturing all the liquidity, trader interest and all the customer interest on their firms,” he said. Each of those dealers has substantial liquidity on the platform which will be an advantage when the dark pool starts up on Day One, said Pein. This also eliminates the burden of installing a new platform, something that has been a stumbling block to acceptance of new platforms.

In terms of the dark pool’s operations, TMC will serve as the central counterparty to each trade, manage credit limits and handle clearance and settlement.

Codestreet Dealer Pool will leverage TMC Bonds’ long competency in running an ATS and in straight through processing, said Pein, adding that it has connectivity to all the dealers.

TMC Bonds operates TheMunicenter.com, an electronic fixed income marketplace for fixed income products ranging from municipals to taxable bonds including agencies, CDs, collateralized mortgage obligations, corporates and Treasures. While the ATS has been popular in the retail market space, the new dark pool is a way to enter the institutional credit space.

Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio